pool of assets is called the “segregated fundspool.” At all times the ﬁrm must ensure thatit maintains at least as much value in thesegregated funds pool as is required to coverits liabilities to customers. Because the ﬁrmmust often meet obligations of its customersto clearinghouses before it can collect fromthose customers, it must add a signiﬁcantcushion of its own assets into the segregatedfunds pool.
e bank accounts or custody accountsthat hold client assets, whether at the FCMor at a clearinghouse, are often referred toas “client omnibus accounts,” because they hold assets of many individual customerspooled together.Each day the FCM must perform a “seg-regation calculation” in which it veriﬁes thatit is in compliance with the segregation re-quirements.
e FCM must ﬁle a daily elec-tronic report showing its segregation calcu-lation with its designated self-regulatory organization, and under newly-adoptedDSRO regulations, the DSRO must beprovided with electronic access to the ﬁrm’sbank accounts to be able to verify that thefunds are there.Under LSOC, as applied to customerpositions in cleared swaps, the ﬁrm mustperform a daily segregation calculation inexactly the same way as it does for futures. And client assets are still pooled together,exactly as with futures. However, the FCMmust assure the clearinghouse that whenit meets a margin call to a clearinghousefor customer positions, it never uses valueprovided by one customer to meet an ob-ligation of another customer.
is requiresFCMs to perform a more precise calcula-tion of each customer’s obligations to theclearinghouse.If one or more customers were to defaultto the FCM, and the FCM, in turn, de-faulted to a clearinghouse in the customerorigin, the clearinghouse can use value at-tributable to a particular customer only tocure losses of that customer—and not forany other customer.To achieve these results, there are threekey operational implications: 1) Clientsmust be identiﬁed to each clearinghouseat which they hold positions, 2)
e clear-inghouse must know the speciﬁc positionsof each client, and 3)
e collateral valuefor each client on deposit with the clearing-house must be reported by the FCM to thatclearinghouse at least daily.Because it is critical for the clearinghouseto know the collateral value of each client,the CFTC’s LSOC regulations focus exten-sively on the question of “excess” collateral—i.e., collateral value provided by the cli-ent in excess of the minimum initial marginrequirement for that client.
e regulationsprovide each clearinghouse with a choice.In the ﬁrst alternative, the CCP may al-low FCMs to pass a client’s collateral valueto the CCP in excess of the client’s mini-mum margin requirement. If so, however,the CCP must provide the FCM with a means to provide a daily report of thatvalue.
is is called “client-speciﬁc collateralvalue reporting.” Alternatively, the CCP could elect notto support client-speciﬁc collateral value re-porting.
is latter choice is referred to asthe “no excess” model or the “unallocatedexcess” model. In this model, the protectedvalue for each customer is deﬁned as theclient’s initial margin requirement, and theCCP does not know the customer-speciﬁcattribution of any excess collateral valuethat the FCM provides to the CCP. If theFCM were to default to the CCP in the cus-tomer origin, the CCP could not use thatunallocated excess value to cure losses of any customers, and would have to return it to a bankruptcy trustee when directed to for thebeneﬁt of the clients.Because of the tight deadlines, all threemajor swaps CCPs have elected to imple-ment LSOC ﬁrst in the “no excess” or “un-allocated excess” model but will make the“client-speciﬁc excess” model available toFCMs and customers in 2013.
Client Identiﬁcation,Onboarding andPosition Reporting
All three CCPs indicated that they donot expect the processes for client identi-ﬁcation, onboarding or position reporting to change signiﬁcantly, and that they arealready in compliance with these aspects of the LSOC rules.
e LSOC regime requires FCMs toidentify each customer to the clearinghousethe ﬁrst time that the FCM clears a swapfor that customer and then to provide in-formation to the clearinghouse to identify the customer’s positions at least once eachbusiness day.Helen Fermor, credit business managerat ICE Clear Credit, explained that from anICE perspective, when an FCM onboardsnew clients, it is required to identify the cli-ent legal entity. “We call it a desk ID and we assign that to the client legal entity,” shesaid. “So there should be no change to theclient onboarding process.”
e CFTC’s LSOC rule requires thepositions of each client to be disclosed tothe clearinghouse at least once per day.
isrule is embodied in the regulatory languagethat refers to the client’s “portfolio of rightsand obligations.” For swaps products at allthree CCPs, the end client is identiﬁed atthe time the trade is submitted for clearing,and hence there is real-time reporting of theportfolio of rights and obligations for eachcustomer.
e FCM’s obligation under thisrule is to reconcile its books and records atleast once per day with the data ﬁles pro-vided by the CCPs, which clearing ﬁrmsalready do.
The Initial ImplementationPhase of LSOC
LSOC will be implemented in a two-phase approach.Initially, FCMs will be required to op-erate in the so-called “no excess” or “unal-located excess” mode, which is designed to
In this ﬁrst phase, anyamount of collateralthat the FCM givesto CME in excessof the minimummargin requirement isdeemed unallocatedclient excess. Andin a default, theclearinghouse can’tuse any of that excessto cover any client’slosses.